Even as the secondary mortgage market made its first bold foray into the world of Web-based trading last week with the alliance of Deutsche Bank Alex. Brown and Internet-based secondary mortgage market trading platform pedestal.com, competitors and market observers alike are wondering whether such a move was premature, viable - or even beneficial for the mortgage-backed securities industry.
The new alliance - in addition to an upcoming multi-dealer platform for Pedestal Inc. which will include unions with other Wall Street banks - will enable customers to buy and sell to-be-announced MBS securities in a competitive bid-ask market via pedestal.com, with Deutsche Bank as the market-maker. The alliance will be an extension of Deutsche's MBS Autobahn program, which launched in October but only dealt with 15- and 30- year Freddie Mac, Fannie Mae and Ginnie Mae passthroughs, and will reportedly bring about greater price transparency, speed and efficiency in MBS trading.
"There is a lot of optionality that the customers are picking up because of this platform that they never had in the voice-traded paradigm," said Dennis Rhee, the managing director at Pedestal in charge of the TBA MBS business. "In the past, Wall Street dealers had advantages over customers in terms of information and market-making abilities. But with electronic trading, it puts customers on a level playing field with the Wall Street market-makers."
Whole Loans or MBS?
At a time when most investment banks have an electronic trading strategy in place, officials at both Pedestal and Deutsche Bank are hailing the alliance as a way for customers to get increased liquidity and efficiency for TBA MBS pools.
However, online competitors are wondering whether alliances such as the one with Deutsche Bank may prove to be premature for MBS - an already efficient and highly-evolved market.
Moreover, should an Internet trading platform ally itself with anyone at all?
"I think there is concern from most of our companies on the Street side that they won't be able to trust Pedestal to remain neutral in the securities and whole-loan trading after this alliance," said David Levine, chief executive officer of Ultraprise.com, a competing online secondary market outlet that has limited itself to the buying and selling of whole loans. "We are exploring trading MBS, but if we do it it will be with multiple relationships, not just with one relationship."
Clearly, there is a difference of opinion between the two companies as to how to best move the secondary market online. While Ultraprise believes that a reasonable progression towards online trading consists of first assessing the long-term performance of whole loans and then moving on to trading securities, Pedestal believes that an exchange is the best way to trade commoditized bonds most efficiently, while more structured product needs to be placed on the Internet as more of an auction-style format or bulletin board.
"With our system, the bid-offer spread will narrow, and that makes trading more efficient," Rhee said. "With less commoditized markets, people are not as willing to make two-way markets online."
However, Ultraprise's Levine believes that getting whole loans to perform rationally should be the first step. The more logical progression, Levine said, is to do the servicing rights first, and then move on to securities trading.
"Pedestal jumped the gun, because they moved on to MBS without first succeeding at buying and selling whole loans," Levine said. "While we're absolutely committed to moving into all asset classes, our firm belief is that the residential loan market is the largest debt market in the world and you have to build real confidence around technologies and relationships. Once you've gotten efficiency in that market, and liquidity, you move on to other pastures. I think it's a big mistake to move before you've succeeded."
"This is just a baby step," added an MBS trader. "I think it can actually hurt liquidity if it ends up sucking the profitability out of the business on a risk-reward basis. It can create another avenue, and cut out marginal business for the Street, but that doesn't help liquidity. Ultimately, it is an incremental approach - it helps and brings the market forward to electronic trading, but it is an evolutionary step, not a revolutionary one."
More Competition Coming
Still, Pedestal has created a business model that will surely be replicated by other banks and online trading platforms. Already, Rhee said that the company is currently in talks with several dealers. "We would like to have this platform evolve into a multi-dealer platform where customers can put bids and offers," he said.
One MBS industry source summed up the prospect of online MBS trading as follows: "You can succeed in it, if you do it right, but if you do it half-fast, you can get your head amputated."